The Calcutta High Court has held that payments calculated as a pre-determined percentage of turnover or sales, without a direct, item-by-item correlation to the actual expenses incurred by the service provider, do not qualify as “reimbursements” for the purposes of the Income Tax Act. Such payments are to be treated as contractual consideration for services rendered, which, if falling under the definition of ‘work’ as specified in Section 194C (including advertising, broadcasting, etc.), are subject to Tax Deducted at Source (TDS).
Consequently, the Court asserted that the payer has a statutory obligation to deduct TDS on such contractual payments. A failure to comply with this obligation justifies the disallowance of the corresponding expenditure in the hands of the payer under Section 40(a)(ia) of the Act. This obligation on the payer is independent of, and not absolved by, the fact that the recipient (payee) has included the payment in its taxable income and paid taxes thereon.
The Division Bench comprising Justice Rajarshi Bharadwaj and Justice Uday Kumar observed that the Tribunal’s reasoning for upholding the disallowance was well-founded and comprehensive. The Bench scrutinized the appellant’s claim that the payments were mere reimbursements and concurred with the Tribunal that they were, in fact, contractual payments for services like advertising, sales promotion, handling, and storage, which are covered under the provisions for contracted work in Section 194C of the Act.
A crucial observation was the distinction between genuine reimbursements and the payments in question, clarified the Bench, while noting that the genuine reimbursements are characterized by being post-facto payments directly linked to specific, documented expenses supported by bills or vouchers.
In contrast, the Bench found that the payments made by the appellant were predetermined fixed percentages of net sales, lacking a direct correlation to actual expenses incurred. This structure made them appear as fixed commissions or service fees, not reimbursements. The Bench also noted the appellant’s admission in a letter, that it lacked its own marketing infrastructure and relied on contractual agreements with its group companies for these services.
Further, the Bench emphasized that the primary obligation to deduct TDS rests with the payer at the time of payment or credit. This statutory duty cannot be substituted by the subsequent compliance of the payee, such as including the amount in their income and paying taxes on it, or by the payee deducting TDS on their own downstream transactions. The Bench stated that allowing such a substitution would undermine the legislative intent of collecting tax at the source and could create avenues for tax avoidance.
Briefly, the appellant, a part of the Dey’s Medical Stores Group, is engaged in the manufacturing of products like Keo Karpin Hair Oil and certain medicines. The appellant utilized the infrastructure, marketing, and sales promotion services of its group companies on a reimbursement basis. Pursuant to agreements, the appellant reimbursed the group companies for various expenses. Specifically, it paid Rs. 2.86 Crore towards sales promotion, advertisement, and marketing expenses, and Rs. 48.19 Crores for handling, storing, and collection services.
These amounts were not based on actual expenses but were calculated as fixed percentages of the appellant’s net sales realization. For instance, advertisement expenses were reimbursed at 10% of net sales of Keo Karpin Hair Oil, and sales promotion for pharmaceutical products was reimbursed at 19% of net sales. The recipient companies treated these payments as income and deducted Tax at Source (TDS) on their own downstream payments where applicable.
The Assessing Officer disallowed these expenses under Section 40(a)(ia) of the Income Tax Act, because the appellant had failed to deduct TDS on these payments. While the Commissioner of Income Tax (Appeals) reversed this order, the Income Tax Appellate Tribunal partially upheld the disallowance.
Appearances:
Senior Advocates J.P. Khaitan, along with Advocates Pratyush Jhunjhunwala, Sruti Datta, and Sakshi Singhi, for the Appellant/ Taxpayer
Advocates Prithu Dudhoria and Sukanya Dutta, for the Respondent
